Sample Questions for Mid-Term Exam

1 . If the one year discount factor is 0.8333, what is the discount rate (interest rate) per year?

A) 10%
B) 20%
C) 30%
D) None of the above

[ (1/.833)-1] = 20%  


 = ?

2. If the present value of $480 expected to be received one year from today is $400, what is the discount rate?
A) 10%
B) 20%
C) 30%
D) None of the above

[ (1/(400/480)) - 1] = 20% 

 = 1
 = ?
 = .833
 = 0
 = 1

3. An initial investment of $400,000 will produce an end of year cash flow of $450,000.  What is the NPV of the project at a discount rate of 10%?
A) $9090.90
B) $409,090.90
C) $0 (zero)
D) None of the above

{450,000 * [1/(1+.10)]} - 400,000 =  409,090.90909 - 400,000 = 9090.90


 = 1
 = 10
 = ?
 = 0
 = 450,000

Solve for PV = 409,090.909 ; subtract 400,000 and get NPV of 9090.90

4. Current price of Company X's stock is $ 100.  The table below gives the data on end of the year prices and probabilities dependent on the state of the economy.  Calculate the expected return for the stock.

  Economy         Probability     End of the year price
  Growth            .5                           $130
  Recession        .5                           $90

A) 10%
B) 15%
C) 20%
D) None of the above

Simply computer the rates of return relative to $100'; (30% and negative 10%) ; multiply each by .5 and add
5. The opportunity cost of capital for a risky project is
A) The expected rate of return on a government security having the same maturity as the project
B) The expected rate of return on a well diversified portfolio of common stocks
C) The expected rate of return on a portfolio of securities of similar risks as the project
D) None of the above
 6. An annuity is defined as
A) Equal cash flows at equal intervals of time forever
B) Equal cash flows at equal intervals of time for a specific period
C) Unequal cash flows at equal intervals of time forever
D) None of the above
7. If the five year present value annuity factor is 3.791 and four year present value annuity factor is 3.170, what is the present value of $1 received at the end of five years.
A) $0.621
B) $1.61
C) $0.315
D) None of the above

Simply subtract the 3.170 from the 3.791 and you have the factor for year 5.

8. PC Company stockholders expect to receive a year end dividend of $10 per share and the stock will then be sold for $122 dollars per share.  If the required rate of return for the stock is 20%, what is the current value of the stock?
A) $100
B) $122
C) $132
D) $110

Find the Present Value of $132 at 20%  (easy way is to divide the $132 by 1.20) and you have $110.00
9. The constant dividend growth formula Po = D1 /(y-g) assumes:
A) The dividends are growing rate at a constant rate g forever.
B) y > g
C) g is never negative.
D) Both A and B
10. The following measures are used by firms when making capital budgeting decisions except:
A) Payback period
B) Internal rate of return
C) Net present value
D) P/E ratio
11. Which of the following cash flows should be treated as incremental flows when deciding whether to go ahead with an electric car?
A) The cost of research and development undertaken for developing the electric car in the past three years
B) The annual depreciation charge
C) The reduction in taxes resulting from the depreciation charges
D) Dividend payments
12. A firm has a general purpose machine which has a book value of $500,000 and is sold for $600,000 in the market.  If the tax rate is 30%, what is the opportunity cost of using the machine in a project?
A) $500,000
B) $600,000
C) $570,000
D) None of the above

You have to pay 30% tax on the $100,000 "gain" so would lose $30,000 of the $600,000 for an ending amount of $570,000
13. What has been the average risk premium on common stocks between 1926 and 2000?
A) More than 10%
B) Between 7% and 9%
C) Between 2% and 5%
D) Less than 2%
14. Mega Corporation has the following returns for the past three years: 8%, 16% and 24%.  Calculate the variance of the return and the standard deviation of the return.
A) 64 and 8%
B) 128 and 11.3%
C) 43 and 6.5%
D) None of the above

The average or mean is 16% so find the sum of the squared differences which would be 128 and divide by (n - 1) to get 64.  The std. deviation is the square root of the variance or 8
15. Stock A has an expected return of 20%, and stock B has an expected return of 12%.  The risk of Stock A as measured by the variance of the returns is twice that of stock B. If the two stocks are combined equally in a portfolio, what would be the expected return of the portfolio?
A) 16%
B) 12%
C) 20%
D) Need more information to answer

The expected return is the weighted average of the individual returns or 10% + 6% = 16%.  The variance has nothing to do with the returns
16. Maximum diversification is obtained by combining two stocks with a correlation coefficient equal to:
A) +1.0
B) 0.0
C) -1.0
D) +0.5
17. If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely?
A) Rejecting good low risk projects
B) Accepting poor high risk projects
C) Both A and B
D) Neither A nor B
18. The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15% and that of the market portfolio is 10%, 10% and 16%.  Calculate the expected return for the stocks and the market portfolio.
A) RA=8% RM= 12%
B) RA= 12% RM=8%
C) RA=10% RM=15%
D) None of the above

Simply add each column and divide by "n" or 24%/3 = 8% and 36%/3 = 12%
19. Given the following data: Long term debt = 100; Value of leases = 20; Book value of equity = 80; Market value of equity = 100, calculate the debt ratio.
A) 0.56
B) 0.60
C) 0.55
D) 0.50
E) None of the above

Total value of firm equals = 200 and fixed obligations = 120 so dividing gives the 60%.  Debt ratios are usually done relative to book rather than market values
20. Given the following data: Sales = 2000; Cost of goods sold = 1500; Average total assets = 1600; Average inventory = 100, calculate the asset turnover ratio:
A) 1.25
B) 0.9375
C) 1.33
D) None of the above

Divide Sales of 2000 by total assets of 1600 and get 1.25.  Cost of Goods Sold and Inventory are not relevant
21. A company has forecast sales in the first 3 months of the year as follows (figures in millions):  January, $60; February, $80; March, $100. 60% of sales are usually paid for in the month that they take place and 40% in the following month.  Receivables at the end of December were $24 million.  What are the forecasted collections on accounts receivable in March?
A) $88 million
B) $92 million
C) $100 million
D) $140 million

Collect 60% of March sales for $60 and 40% of February sales for $32.  Add and get total collections of $92 million
22. Suppose you purchase goods on terms of 2/10, net 50.  Taking compounding into account, what annual rate of interest is implied by the cash discount? (Assume a year has 365 days.)
A) 2%
B) 20%
C) 52%
D) 18%

((1 + (2/98))^(365/40) = 1.2024.  Subtract the 1 and round to 20%

23. Determining the appropriate target cash balance involves assessing the trade-off between:
A) Income and diversification
B) The benefit and cost of liquidity
C) Balance sheet strength and transaction needs
D) All of the above
24. The interest rate on a loan is set at "1% over LIBOR." If the LIBOR rate is 5% then the interest rate on the loan is:
A) 5%
B) 4%
C) 6%
D) 7%